Don’t Miss the Opportunity in Emerging Markets

Emerging markets are volatile, but also very cheap

Recently Brian Rogers, chief investment officer of T. Rowe Price, gave a very good account of emerging markets as part of the Barron’s Roundtable Part 3:

“The buy side hates emerging markets. The sell side hates emerging markets. Technicians and quants hate emerging markets. I think it’s great. Combine this bearish sentiment with what is, at worst, a neutral valuation case, and things start to look positive… Valuations are attractive, relative to developed markets.”

It’s hard to argue with Rogers’ comments from the Barron’s Roundtable. Emerging markets are the most hated asset class on the planet right now. As fellow panelist Mario Gabelli pointed out in reply, “Even consultants who advise pension plans and have long preached investing in emerging markets are changing their minds.”

And investors have been running for the doors. Emerging-market equity funds have seen 14 straight weeks of redemptions. In the past week alone, $9 billion has flowed out of emerging market stock and bond funds.

Slower growth in China, Fed tapering (and the corresponding unwinding of “risk-on” trades) have combined to create a toxic mix for emerging market currencies and, in turn, equities. (I recently discussed the emerging market situation with Fox Business’ Charles Payne.) But let’s look at the other side of the coin here.

Emerging Markets Are Cheap

With few exceptions (such as Brazil), emerging market currencies are already cheap, at least as measured by The Economist’sBig Mac Index. As an extreme example, the South African rand is undervalued by 66%. Could they get cheaper? Absolutely. But at today’s prices there is less risk of decline than there was two years ago, when many emerging market currencies were expensive.

Equities in emerging markets are also very cheap. Whether based on the Market-Cap-to-GDP ratio, the Cyclically-Adjusted Price/Earnings ratio, or the good, old-fashioned trailing-12-month P/E ratio (subscriptions may be required for each source), as a group, emerging markets are cheap. Using examples from the Financial Times, the markets of Argentina, China, and Turkey trade for 4.3, 6.5, and 7.8 times earnings, respectively. By contrast, the U.S. market trades for 18.6 times earnings.

Finally, and perhaps most importantly, I should point out that the event most responsible for the recent spate of risk aversion — the Fed’s tapering of its quantitative easing program — is vastly overhyped.

Even while “QE Infinity” has been scaled back from its original $85 billion to $65 billion, yields on U.S. Treasury securities have actually fallen. At time of writing, the 10-year Treasury yields less than 2.7%. I wrote about this last week, and I would reiterate one of my main points here:

“As the experience of Japan proved, a country emerging from a credit bubble and bust can have much lower long-term yields for much longer than anyone believed possible before the fact. More than two decades after Japan’s bust, the yield on 10-year Japanese bonds is a pitifully low 0.63%. In the absence of inflation — and with energy and commodity prices looking to stay low for the foreseeable future, I expect inflation to be a non-factor for the next several years — we won’t see higher bond yields.”

How to Play Emerging Markets

Where does this leave us today? Bear markets can take on a life of their own, as selling begets selling. And an outright currency collapse in Argentina or Venezuela (or both!) could create another wave of volatility. But for the intrepid investor, it makes sense to average in to emerging markets on any weakness.

One good candidate? The EG Shares Beyond BRICs ETF (BBRC), which I recently highlighted here. The ETF has a 75% weighting to more advanced emerging-market economies — such as Mexico, Indonesia, Turkey and South Africa — and a 25% weighting to up-and-coming frontier economies, such as Nigeria, Kenya and Vietnam.

I wouldn’t recommend you bet your retirement on it, but overall, BBRC is a nice collection of companies from frontier and emerging markets.

Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click hereto receive his FREE weekly e-letter covering market insights, global trends, and the best stocks and ETFs to profit from today’s exciting megatrends. This article first appeared on MarketWatch.